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Fall in US unemployment rate fails to enthuse markets

Headline economic data releases point out that a gradual and sustained recovery in the US economy is underway. But it is quite surprising to note that the US Dollar and US 10-year yields have not been inching higher and remain well below the highs seen in 2013, after the Federal Reserve first announced its decision to scale back on its monthly purchases of bonds and mortgage backed securities.

Friday saw the release of one of the strongest jobs data in recent months. The April labour market report showed that US non-farm payrolls rose by 288,000 in the month of April, up from 203,000. The most optimistic Wall Street economists were calling for a 250,000 rise but what really caught the market by surprise was the sharp improvement in the unemployment rate, which fell to 6.3 percent, its lowest level since September 2008.

At best, economists were looking for an improvement to 6.5 percent from 6.7 percent, according to Kathy Lien of BK Asset Management. This should have been positive for US 10-year yields and the greenback but after a sharp move higher post the data release, they ended the session lower. 
Currency traders weren’t excited with the massive drop in the unemployment rate as the labour force participation rate dropped to 62.8 percent from 63.2 percent -- thus implying that the primary reason for the drop in the unemployment rate was the shrinking workforce. Around 806,000 people dropped out. Further, wage growth was stagnant as average hourly earnings did not show any improvement.

Dollar weakness was also a function of the strength displayed by other major currencies last week, especially the Euro and the British Pound. The Euro was stronger against the US Dollar as Spanish GDP growth rose 0.4 percent, the fastest pace in six years. Further, German unemployment surprised to the upside with the number of people filing for unemployment benefits in the month of April dropping 25,000 versus a forecast of 10,000. The deflationary threat was seen abating as Euro zone consumer prices grew 0.7 percent in April and while this was slightly slower than expected, it was still higher than March. The British pound hit a four and a half year high of 1.69 to the dollar last week.

Last week, the Federal Open Market Committee also decided to stay on course to taper down its quantitative easing (QE) program by another $10 billion. The market may have its doubts about the underlying strength of the US economy but the central bank is all set to wind up the largest monetary stimulus of all time. It was a unanimous decision to taper down as shown in the FOMC minutes. If the central bank continues its current pace of tapering, asset purchases should reach zero by October or December at the latest. 
As the Fed has said earlier, we can expect the first rate hike six months after QE is completely wind down. Thus, the market should be pricing in a rate hike by May-June of 2015.
It is just a matter of time before the US Dollar index and yields on US 10 year treasury bonds start inching higher. Entering into long trades in the greenback and US yields are a good risk reward bet going forward.  IANS
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